10:12 a.m., June 10, 2010----A University of Delaware alumnus is gaining national attention for a thoughtful and timely book on the financial crisis.
Mark T. Williams, a 1985 graduate of UD's Alfred Lerner College of Business and Economics now on the faculty at Boston University, is the author of the new book Uncontrolled Risk: The Lessons of Lehman Brothers and How Systemic Risk Can Still Bring Down the World Financial System, published by McGraw-Hill.
The book was born of a conversation Williams had with his 12-year-old daughter who asked a simple question with a complex answer, “Why did Lehman Brothers fail?” The author was fascinated in uncovering why a household name on Wall Street could simply evaporate overnight.
That set off a year of research and hundreds of hours of interviews in preparing the book, which traces the rise and fall of the firm, which had started in 1844 in Montgomery, Ala., as a dry goods store and later became a cotton brokerage and a powerful investment bank before its collapse in September 2008.
Uncontrolled Risk uses Lehman as a case study to explain how risk taking was an important part of the building the company, but how excessive risk taking caused both the greatest bankruptcy in history and triggered a global financial meltdown that has investors worldwide still at risk.
The book also offers a 10-point plan for reform of the financial industry so that it can ward off future such calamities. Several of the points deal with a need to overhaul the system, requiring higher capital standards and constraints on leverage. Another calls for a change in behavior among executives, who Williams said must accept greater accountability and face meaningful penalties for destructive risk taking behavior. After the financial crash, many Wall Street executives were able to simply walk away from the crime scene.
“Throughout the book there is a consistent theme of the need for companies, individuals and policymakers to take greater responsibility for their actions and act in a higher ethical manner,” Williams said. “Lack of accountability was a driving factor in the crisis. Growing up in a small state and in a smaller town -- Georgetown, Del. -- you were taught by example, ethics and accountability. The local pharmacist, farmer or baker could not survive if they did not adhere to these basic standards. Ethical behavior involves trust, honesty and integrity and is the fundamental building block needed for a strong company. I think Wall Street can learn a lot by how Main Street conducts its business. Ethics and finance should not be viewed as mutually exclusive.”
As it tracks Lehman, the book also provides insight on the history of finance in America and highlights changing trends in the finance industry.
Williams argues that the failures of the behemoth financial institutions were because “excessive risk was taken and not controlled.” Stated simply, banks were undercapitalized compared to the risky bets placed. Many banks were willing to take such large risks in the pursuit of large perceived returns.
“This is an important story not just because of what happened on Wall Street but what did not happen in Washington,” Williams said. “It is a story about failed policy and the inability of regulators to supervise the activities on Wall Street. Politicians have been very quick at pointing a finger at Wall Street and saying wild risk taking caused the downfall of firms like Lehman. And while this statement is partially correct, it ignores the fact that oversize risk taking was happening over a period of years under regulatory oversight.”
History of investment banking
William devotes a chapter to the history of investment banking in America, noting Delaware's leadership in the establishment of a business court that dates back to 1792. This legal system allowed banking to take hold and helped to supply the capital needed to build a new nation. The Court of Chancery remains one of the most able business courts in the world, and a large number of major corporations are incorporated in the state.
Through much of the 19th century, investors remained partial to bonds over stocks, which provided an unsecured interest and no payment guarantees. That changed in the Roaring Twenties, Williams said, when “the instant wealth created in the market run-up put stock investing on the map.”
The Great Crash of 1929, however, stunned investors and it took until 1954 for the Dow Jones Industrial Average to regain pre-crash levels. Williams said shareholder activism -- an important market safeguard -- declined by the late 1970s when “institutional investors and pension funds rose in dominance.”
These large investors, controlling billions in stock, expressed displeasure with management less in the boardroom and more in the selling of company stock. In many companies, including Lehman, boards become more of a CEO friendship network and less of an independent check and balance.
Following the 2008 crash, Williams said he sees an opportunity to return to meaningful shareholder activism. “The size and scope of the financial losses experienced has triggered the need for greater activism and oversight,” he said, citing proposed House legislation that would give shareholders a “say on pay” over corporate executives. There has also been “a real movement targeting companies to improve corporate governance practices.”
A leader in the effort, Williams said, is UD's Charles Elson, Edgar S. Woolard, Jr., Chair of Corporate Governance and director of the John L. Weinberg Center for Corporate Governance. Elson said of the book that it “gives the reader much food for thought on the regulation of our financial system and its interplay with corporate governance reform in the United States and around the world.”
What happens next?
Williams said the future of the financial system remains murky. “What the proposed financial overhaul will look like after it goes through the legislative meat grinder is still not clear. There are two Congressional bills, in the Senate and House of Representatives, which need to be reconciled,” he said. “What is clear is that there are a lot of structural cracks in our financial system that need to be fixed as a complete system and not addressed in a Band-Aid or one-off fashion. Without correcting these structural problems, another financial crash like that in 2008 will occur. The failure of Lehman has taught us the interconnectedness and fragility of the global market. Whether a company such as Lehman or a country such as Spain, Greece or Italy, if excessive risk is taken, systemic risk will remain high.”
Williams has put forward a 10-point plan to address the structural problems, writing:
- We must acknowledge systemic risk exists;
- The Fed needs to regain credibility;
- Creation of an independent systemic risk regulator;
- Higher capital levels should be mandated;
- Leverage constraints must be in place;
- Smarter compensation schemes are critical;
- Board must exercise better oversight;
- Regulations need to remain current;
- A firm policy stand on moral hazard should be taken and articulated; and
- Greater executive accountability is required.
He puts emphasis on the need for higher capital standards to be imposed on banks, noting that since 2008 more than 200 banks have failed and that “those that survived had more capital to cushion against financial loss.” This recommendation is not popular with bankers as it puts downward pressure on profit margins.
With more Americans invested, either through pension funds or directly through brokerage accounts, Williams said he also believes “there is a clear need for stronger investor education in public schools and colleges,” adding this is an area in which institutions of higher education need to do a better job.
He said the proposed Consumer Protection Agency in the financial overhaul bill “will help to highlight the risks and opportunities but individual investors still need to improve their understanding of the tradeoff of risk and return.” In an efficient market, higher returns can only come by taking higher risk.
Williams said he wrote the book “with the goal of educating lay investors so they can make better investment decisions.” A better educated population can make better decisions on how to regulate its financial markets.”
About the author
Williams is a 1985 graduate of the Lerner College of Business and Economics and was a member of UD's cross country team. He earned a master's degree in finance from Boston University in 1993. He cites Robert Schweitzer, the Donald J. Puglisi Professor of Finance, and Raymond Callahan, professor emeritus of history, and his late father, William H. Williams, who was on the UD history faculty, as igniting his interest in banking and history.
He has been on the Boston University faculty since 2002, specializing in capital markets, and in 2008 was awarded the prestigious Beckwith Prize for Excellence in Teaching.
Williams has much practical experience as a trust banker, Federal Reserve Bank examiner and senior trading flood executive for a major energy company. Also, he has been a guest columnist for Reuters, Forbes and the Boston Globe and is interviewed frequently by major media including The New York Times, the Wall Street Journal, Financial Times, Bloomberg News and National Public Radio.
Williams said he got into the field of risk management “by luck,” although it had as much to do with market crashes in 1987 and 1989 while working in trust banking that “spurred my interest in how to manage risk.” With the banking industry in disarray in 1991, he went to graduate school at Boston University to “retool my career.”
There he “became fascinated by options and how they could be used to mitigate or increase risk,” and upon graduation accepted a position with the Federal Reserve as an examiner measuring bank risk taking.
He later joined the Boston-based trading company Citizens Power and in 2002 the finance faculty at Boston University.
Article by Neil Thomas